Royal Mail: trip to Wonderland

Curiouser and curiouser. Had Lewis Carroll's Alice been a stock market investor, she might well have felt she was in Wonderland when Royal Mail shares made their stock market debut on Friday. Priced at the very top of the initial 260p-330p offer range, they promptly shot to 440p, a first-day trading premium of more than 30 per cent. For anyone aged 40-plus, it was eerily reminiscent of the 1980s, when privatisations conducted under Margaret Thatcher's governments - British Telecom, say, or British Airways - enjoyed similar stock market receptions on day one.

Markets, though, are rational. And explanations for Friday's excitement can probably be divided into three categories. First, there was the long, behind-the-scenes marketing campaign, which meant institutional demand for the shares was in place before the formal offering began.

Second, there was the dividend factor. Even at the 330p offer price, Royal Mail shares were carrying an implied annual yield of more than 6 per cent. Better still, executives were promising a "progressive dividend policy" in future years. Generous payout policies do not add any value. Still, for certain investors they can be very convenient. So, in a low interest rate environment, and with savings product returns typically running at under 2 per cent a year (albeit with no risk to underlying capital), Royal Mail stock stood out.

Finally, there was the "froth" factor - which multiplied hugely as optimism about the offer's success grew. By the end, the institutional portion of the offer was more than 20 times oversubscribed, split 50:50 between long-term investors and shorter-term players; the retail portion was seven times oversubscribed. And no one did more to help this lather intensify than those politicians who loudly declared that the shares had been underpriced.

But on stricter valuation terms, nothing has changed. At 440p, the shares trade on an enterprise value to 2012 earnings after transformation costs of almost 8. The implied yield falls to 4.5 per cent, below that at Vodafone. This looks pricey relative to postal peers, even though Royal Mail has good scope for margin improvements. Labour unrest looms, and revenue growth is likely to be modest. Even Alice woke up for tea.

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